Carney Gets ‘Escape Velocity’ Mandate With Limiter: U.K. Credit

Incoming Bank of England Governor
Mark Carney was handed scope to pursue “escape velocity” for
the U.K. economy so long as it doesn’t come at the cost of
surging inflation.

In a rewrite of the rules governing the central bank as a
repeat recession looms and Carney prepares to replace Mervyn King in July, Chancellor of the Exchequer George Osborne
yesterday twinned a rededication to 2 percent inflation with a
call for “monetary activism” to revive economic growth.

Investors responded by pushing the pound higher against the
dollar, yet also increasing bets inflation will accelerate as
the U.K. 10-year breakeven rate rose to 3.28 percent. Even as
Osborne resisted a more aggressive overhaul, Carney won room to
justify overshooting inflation and was told to consider adopting
Federal Reserve-style guidance on the likely length of easy
monetary policy.

“The new remit is at face value not terribly different
from the current one, but the devil is in the detail,” said
David Tinsley, an economist at BNP Paribas SA who formerly
worked at the Bank of England. “We are very comfortable with
our long-held call that further monetary loosening in size is
coming.”

Pound Strengthens

The pound strengthened as much as 0.6 percent yesterday
before easing to close little changed. It surged 0.5 percent to
$1.5171 today after data showed U.K. retail sales rose more than
forecast in February and the budget deficit narrowed. Sterling
has fallen 6.7 this year, partly on speculation the Bank of
England would do more to rally growth.

The 10-year breakeven rate, a gauge of inflation
expectations derived from the difference in yield between
regular and index-linked bonds, was at 3.27 percent today after
climbing 1 basis point to 3.28 percent yesterday. It reached
3.37 percent on March 14, the highest in 4 1/2 years.

Geoffrey Yu, a senior currency strategist at UBS AG in
London, said the pound rose yesterday as many investors “were
positioned for even more aggressive measures” on the BOE’s
remit. Still he said the changes may still “hurt sterling in
the medium- to longer-term.”

“There will be more flexibility on the inflation target,”
he said. “As this gets thrashed out and more details emerge,
that may continue to be bearish for the pound.”

Price Stability

Policy makers are now likely to loosen policy through a
number of channels with more quantitative easing, rate guidance
and credit easing the early favorites, said Michael Saunders,
chief western European economist at Citigroup Inc.

The refreshed mandate, which follows Carney’s appointment
in November and his December triggering of a debate on the
policy framework, avows the “primacy” of price stability and
retains the 2 percent goal. Inflation climbed to 2.8 percent in
February.

Osborne avoided greater aggression after the Treasury
debated the merits of widening the target, monitoring other
inflation measures or replacing it with a gross domestic product
goal. In a review of the policy framework, it said aiming to
achieve a set rate of nominal GDP growth could present
communication challenges and leave inflation expectations less
well-anchored. It rejected targeting other gauges of inflation
as unlikely to add value over the status quo.

“It’s toward the lower end of what he could have done,”
said Simon Wells, chief U.K. economist at HSBC Holdings Plc in
London and former Bank of England official. “It’s not a game
changer.”

Unconventional Tools

Seeking to bolster an economy he now expects to grow just
0.6 percent this year -- half the pace forecast just three
months -- and with little budgetary space to aid, Osborne
blessed the BOE’s use of unconventional tools and said it could
rationalize ignoring inflation in breach of the 2 percent aim.
It must communicate the “trade-off” of doing so and outline an
appropriate “horizon” for returning price growth to target.

While Osborne kept the inflation target, he will “consider
the case” for a revision at every budget and make a decision
“on its merits.” He also said officials are “actively
considering” extending the Funding for Lending Scheme aimed at
easing credit.

Guidance Review

In a nod to where U.K. monetary policy may be headed, the
chancellor said the central bank may wish to follow the lead of
Canada and the U.S. in setting out guidance for how long policy
could stay loose. He called for an August review of whether the
BOE should mimic the U.S. by setting “intermediate thresholds”
that will guide policy change.

The Fed in December tied its interest-rate outlook to
unemployment and inflation, saying for the first time it will
keep rates low “at least as long” as unemployment remains
above 6.5 percent and if the Fed projects inflation of no more
than 2.5 percent one or two years in the future.

The U.S. central bank said yesterday it will keep up its
bond buying at a pace of $85 billion a month even as the world’s
largest economy and the job market pick up. In a statement after
a two-day meeting in Washington, it said labor-market conditions
“have shown signs of improvement in recent months but the
unemployment rate remains elevated.”

‘Calling Card’

Carney, currently the governor of the Bank of Canada, has
been an advocate of policy guidance, arguing Canada’s 2009
pledge to keep its benchmark at a record low until mid-2010
helped contain market borrowing costs without sacrificing
inflation-fighting credibility.

“Forward guidance is Carney’s calling card,” said Robert Wood, an economist at Berenberg Bank in London and former Bank
of England official. “We continue to expect forward rate
guidance and more asset purchases after Carney takes over.”

By contrast, Richard Barwell, an economist at Royal Bank of
Scotland Group Plc, who also once worked at the central bank,
said more aggressive monetary policy may not do much for an
economy beset by structural challenges such as weak lending and
could end up fanning inflation.

“The bank is on the edge of what it can do,” he said. “A
bit more quantitative easing is not going to guarantee a rally
in output.”

Political Independence

U.K. officials have previously resisted telegraphing,
arguing it would be wrong to lock in future decisions and saying
it’s hard to commit the nine-member Monetary Policy Committee to
a path when its composition regularly changes. The tactic also
risks undermining a central bank’s credibility if it changes
course sooner than anticipated.

Brian Hilliard, an economist at Societe Generale SA in
London, said directing the BOE to study forward guidance also
raises questions about its political independence.

A study last year by economists at the Federal Reserve Bank
of San Francisco nevertheless said the Bank of England could
have greater impact on bond yields if it better communicated the
outlook for policy. It estimated about 60 percent of the recent
decline in U.S. yields reflected lower expectations for future
monetary policy, while saying none of the drop in U.K. yields
was driven that way.

Already Flexible

Current central bankers including Deputy Governor Charles Bean and colleagues Paul Tucker and Ian McCafferty have said the
current U.K. framework is already flexible and allows it to look
through temporary periods of above-target inflation to ensure
stable output.

Such flexibility has been evident given the bank has
continued to loosen policy even though inflation hasn’t been
beneath 2 percent since November 2009 and reached as high as 5.2
percent in 2011.

The MPC has kept its key interest rate at a record low of
0.50 percent for four years, conducted 375 billion pounds of
quantitative easing and tried to ease credit. It’s justified
that stance on the grounds that the surge in inflation is due to
energy prices, tax increases and the pound’s decline.

The dilemma of what to do next was evident yesterday in
minutes of the Bank of England’s March policy meeting. While
King again united with two colleagues in seeking a 25 billion-
pound increase in quantitative easing, the majority of the MPC
opposed more bond buying for fear it would erode their
credibility and push the pound lower.

Carney has indicated he is open to easing, saying in
January that central banks aren’t “maxed out” and should
achieve “escape velocity” for their economies.

“With growth in short supply, central banks will have to
overshoot on quantitative easing to make sure activity builds
and inflation expectations are preserved,” said Neil Williams,
chief economist at Hermes Fund Managers in London. “Because the
alternative -- deflation expectations -- is unthinkable.”